Diamond’s Exit Shows Libor Only What Each Bank Says It Is

By Paul Armstrong -
Jul 4, 2012

The resignation of Barclays Plc (BARC) Chief
Executive Officer Robert Diamond for the firm’s role in rigging
the London interbank offered rate underscores the disconnect
between the market’s perception of bank borrowing costs and the
benchmark for $360 trillion of global securities.

Barclays has gone from saying in January it can borrow for
three months at interest rates that were on average above other
banks to saying it can borrow more cheaply than its peers even
though the cost of insuring the London-based firm’s debt using
credit-default swaps rose 36 percent, according to data compiled
by Bloomberg.

The contrast between banks’ daily submissions for Libor and
other measures of their creditworthiness shows why regulators
from Europe to the U.S. are beginning to fine them for
manipulating the market for short-term rates. While the British
Bankers’ Association reveals Libor submissions from each bank,
the process that the firms use to come up with their individual
rates is opaque and not based on actual transactions.

“After the Barclays admission, we have proof that Libor is
not a reliable benchmark,” said Alessandro Giansanti, a senior
rates strategist at ING Groep NV in Amsterdam.

Libor is hardwired into the world’s financial system,
meaning credible alternatives have been slow to develop. ICAP
Plc, which started the New York Funding Rate in 2008 amid
concern about the veracity of Libor, cut the minimum number of
participants in April required in its daily survey of unsecured
loans because of a decline in interbank lending.

‘Archaic Process’

Libor is determined by banks’ daily estimates of how much
it would cost them to borrow from one another for different time
frames and in different currencies.

Princeton University economist and former Federal Reserve
Vice Chairman Alan Blinder said in an interview on Bloomberg
Television’s “Market Makers” with Erik Schatzker and Scarlet Fu on July 2 that a “real market” may come from the Libor
investigations and that the current system is an “archaic” way
to set rates. At least a dozen firms are being probed by
regulators worldwide for colluding to rig the rate.

Barclays employees overseeing Libor submissions routinely
accommodated requests that benefited traders at their own and
other banks, according to the U.S. Commodity Futures Trading
Commission. The BBA, which has overseen Libor for 26 years,
created a steering group of bankers and regulators in March to
consider reforms in light of the probes.

Low-Balling

The BBA was aware that banks including Barclays were low-
balling their Libor submissions during the financial crisis to
avoid the perception they were struggling to borrow cash,
according to CFTC documents.

Diamond, 60, quit July 3 after the U.K.’s second-biggest
lender was fined a record $451 million when investigators found
traders and senior managers “systematically” tried to rig
Libor and Euribor, its euro equivalent. Chief Operating Officer
Jerry Del Missier also stepped down, while Marcus Agius, who
said this week he planned to resign, will become full-time
chairman and lead the search for a new CEO.

Process ‘Dead’

Diamond came under increasing pressure from politicians
including British Prime Minister David Cameron before his
position at the head of Barclays became untenable. Cameron’s
deputy, Nick Clegg, openly called for the CEO to go this week.

“The idea that one can base the future calculation of
Libor on the idea that ‘my word is my Libor’ is now dead,” Bank
of England Governor Mervyn King said at a press conference to
present the central bank’s Financial Stability Report in London
on June 29. “It will have to be based in the future, in my
judgment, on actual transactions in order to bring back
credibility to the system.”

John McGuinness, a spokesman for Barclays in London,
declined to comment. Brian Mairs, a spokesman for the BBA,
didn’t return a phone call seeking comment.

The rate Barclays says it pays for three-month dollar loans
diverged from the Libor composite on Feb. 27, after largely
tracking it since 1994, BBA data show. The U.K. lender’s rate is
now 12 basis points, or 0.12 percentage point, below the
benchmark, compared with a 16.8 basis-point gap June 1, the
widest since at least 2000.

Spotlight Intensifies

As the spotlight on Libor intensifies, the rates different
banks give to the BBA are diverging, after being virtually
identical at the start of 2007 before the worst financial crisis
since the Great Depression.

The gap between the highest submission, currently from
French lender Societe Generale SA (GLE), and the lowest, from HSBC
Holdings Plc, has increased to 33.8 basis points. On Jan. 3,
2007, when Libor was at 5.36 percent, the gap between the
highest and lowest submissions was just 1 basis point.

Barclays now puts in the second-lowest rate after HSBC,
which says it can borrow at 0.26 percent. Credit-default swaps
insuring HSBC’s bonds rose 4 percent since Jan. 27 to 123 basis
points, according to Bloomberg data. Contracts on Barclays
jumped to 209 from 153 during the same period.

Credit swaps pay the buyer face value if a borrower fails
to meet its obligations, less the value of the defaulted debt.

The CFTC ordered Barclays on June 27 to keep thorough
records on how it sets its Libor submissions and to erect
Chinese walls between traders and rate-setters. It also said
lenders should expect random checks on whether their rates
reflect actual borrowing costs.

CFTC’s Recommendations

As part of its settlement, the CFTC ordered Barclays to
amend how it sets Libor. Submissions should be based on actual
trades if possible. Where no trades have taken place, the rate-
setter can consider factors including how much competitors paid
to borrow and market conditions, the CFTC said.

Rate-setters should be prohibited from “improper
communications” and not work within earshot of derivatives
traders, according to the commission. Barclays must keep
extensive records on all its Libor submissions, including
details on who the rate-setter was and how the figure was
derived. The bank must also undergo annual audits and be willing
to provide data to regulators on demand.

On Sept. 13, 2006, a senior Barclays trader in New York e-
mailed the person who submitted the rate, “Hi Guys, We got a
big position in 3m libor for the next 3 days. Can we please keep
the lib or fixing at 5.39 for the next few days. It would really
help,” according to a CFTC document.

‘Big Boy’

In an exchange on April 7, 2006, a submitter responded to a
request for low U.S. dollar Libor submissions from a swaps
trader with: “Done ... for you big boy,” the CFTC said.

“It’s the damage to confidence that corporates are
concerned about,” said John Grout, the policy and technical
director of the Association of Corporate Treasurers in London.
The group represents borrowers in the loan market, where
interest rates tend to be based on Libor or other interbank
rates. “If people don’t trust these things, you can get
liquidity reducing, you can get investors starting to add
spreads onto corporate borrowing costs, which is not helpful.”

Three members of the new Libor steering committee
interviewed by Bloomberg News last month said changes would be
incremental because structural modifications in how the rate is
calculated could invalidate trillions of dollars of contracts
and result in litigation. They ruled out stripping the BBA of
its oversight and scrapping the survey system in favor of a rate
based entirely on actual trades.

The British government will emphasize to the BBA at the
steering group’s next meeting that only drastic changes will
suffice, according to a person with knowledge of the matter, who
asked not to be identified because the talks are private.

Chancellor of the Exchequer George Osborne, speaking to
lawmakers in London yesterday, said the FSA is “committing
significant resources” to investigate “systemic failures”
over the manipulation of Libor.